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Value of the Convertible Bond as Debt
The value of a convertible as debt is determined by the coupon rate, credit quality of the issuer, length of time to maturity, the call provision, and the market rates of interest. Many of the convertible bonds have call provisions.
The investment value of the bond is determined by discounting both the coupon interest payments of the convertible and the face value of the bond at maturity (assuming it is not converted) at a comparable rate of return used on similar debt.
In other words the value of a convertible bond is the current value of the cash flow of coupon payments and the face value of the bond at maturity, discounting a rate of interest that includes a premium risk to invest in the security.
As with conventional bonds the value of a convertible bond as debt fluctuates with the changes in interest rates in the market. When the rates of interest are increased the prices of convertible bonds decline, and the opposite happens when the rates of interest decline, the price of convertibles increase.
This inverse relation occurs because coupon rates in convertible bonds are fixed. The value of a convertible bond as a straight debt is important because it sets a floor price. When stock prices are being negotiated below the conversion price , the straight bond value provides the floor value, and the convertible option is not consequent with lesser prices in stocks.
When prices of stocks raise above the conversion price, The price of convertible bonds is the conversion value of the stock, the convertible bond is equity in disguise.